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NEW DELHI : How justified is it that today while it takes only a few seconds to send an email or a text message from Mumbai in India to New York in the US, transferring money between these cities can take anywhere between 2-3 days? On top of this delay, transfer fees are also involved—which could be inexplicably high (about 500-1,000).

Now, imagine a world where banknotes have become extinct. Imagine that you are a business owner and you receive payment for a service via “programmable money". The money that is received carries a piece of computer code that could potentially make accounting and tax compliance unnecessary. The money automatically diverts a portion of the proceeds to the tax department.

Both of these futuristic dreams—swift money transfer at low cost and a reduction in the compliance burden—are suddenly within the realm of possibility, if the Reserve Bank of India (RBI) is to be believed. RBI may come out with a model for the implementation of a government-backed digital currency by the end of this year. “Central bank-issued digital currencies (CBDCs) are desirable not just for the benefits they create in payments systems, but also (because CBDCs) might be necessary to protect the general public in an environment of volatile private virtual currencies," said RBI deputy governor T. Rabi Sankar in a keynote speech recently. “CBDC is likely to be in the arsenal of every central bank going forward."

Future of money
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Future of money

The action is not restricted to India. If anything, the country is somewhat late to arrive at the party. Russia, Japan and China had all started working on a government-issued digital currency much earlier. In October 2020, the Bahamas launched the world’s first state-backed digital token. CBDCs have suddenly become the flavour of the season. And it could very well be the future of money.

Many experts believe that while the traditional financial system has helped globalize the world economy, its potential to effectively handle cross-border trade and movement has reached a point of stagnation. Now, a race is on to find a replacement. And who gets there first might matter. “The immediate usage (of CBDCs) is of course as the replacement of (existing) currency notes," said Ananth Narayan, an associate professor at the S P Jain Institute of Management and Research (SPJIMR) and an expert on international banking and financial markets. “But the bigger possibility and aspiration for (many) countries, especially China, could be to replace and upend the SWIFT system. This system of (international) money transfer ensures that the US has a disproportionate control of the (current) global settlement process." “What China may be exploring is to see if (the) CBDC can be a way to internationalize the yuan," Narayan added.

Several domestic priorities are also driving India’s quest. Currently, government authorities can send money straight to a person’s bank account via the direct benefit transfer (DBT) system, but they can’t track whether the money is being used for the intended purpose. As a stop-gap solution, Prime Minister Narendra Modi recently launched the e-RUPI, an electronic voucher-based digital payment system. Programmable money would just make this a whole lot easier.

The way ahead

The modern iteration of money came about with the advent of coins sometime in the 7th century BC, and then, paper money was introduced in China in the 11th century. This concept took a giant leap in the 17th century when the Bank of England became the first public bank to issue banknotes. Since then, most central banks including RBI have been working with the objective of regulating the issue of banknotes and operating the credit and currency system. However, today, policymakers seem to be ready for a new form of money that cannot be seen or touched—CBDC.

A survey conducted in late 2020 by the Bank for International Settlements (BIS)—also known as the central bank of central banks — showed that 86% of the global sovereign monetary institutions were actively researching the potential for CBDCs, 60% were experimenting with the technology and 14% were in the process of deploying pilot projects. China was one of the first major countries to step into the field with the launch of its digital yuan last year.

Globally, there are two factors behind this sudden interest in CBDCs. First is the rise of cryptocurrencies such as bitcoin, and second, the proposed launch of a Facebook-backed digital stablecoin called Diem (formerly known as Libra). A stablecoin is a digital currency that is linked to an underlying asset, such as a national currency like the US dollar or a precious metal like gold. For example, Tether, the largest stablecoin, is backed by the US dollar on a 1:1 basis.

The broad aim for most central banks is to introduce a new form of money, which is programmable, smarter and KYC-enabled. KYC or know your customer guidelines are meant to check and verify the identity of clients or owners of a bank account. There is intense competition between central authorities and private players who are simultaneously attempting to bring in greater efficiency to payments, and central banks certainly don’t want to end up on the losing side.

New type of money

Central bank digital currency, as the name suggests, is essentially a legal tender issued in a digital form, which is managed on a digital ledger (a blockchain). A central bank-issued digital currency will be using the same blockchain technology as cryptocurrencies, but will be deployed in a way so that central banks can be in control of the money and, thus, the monetary policy. Therefore, a central bank-issued digital currency—whether it is a rupee or US dollar—will always need the Federal Reserve or RBI, unlike a cryptocurrency which is traded on multiple private exchanges and doesn’t need any central authority. Simultaneously, a CBDC would also be different from existing forms of cashless instruments such as credit transfers, direct debits and card payments.

According to Tanvi Ratna, founder and chief executive officer of Policy 4.0, an independent research and strategic advisory body, CBDCs have the potential to change the foundation of the banking ecosystem. “A CBDC changes the way money is issued, the way it reaches the citizen from the central bank, and the capabilities that the money has—it can be tokenized, code can be embedded into it," she said. Ratna has helped design the blockchain policy framework of Karnataka and advises the Indian government on its blockchain regulations.

Sumit Gupta, founder and chief executive officer of crypto exchange CoinDCX, believes that both CBDCs and cryptocurrencies will play an important role in introducing people to digital assets. “While both CBDCs and cryptos constitute a dichotomy (one is issued by the state while the other isn’t), both still have close similarities that continue to offer opportunities for the growth of digital finance," he said. Crypto proponents, including Gupta, hope that India will slowly move towards a cashless economy, with its foundations built on CBDCs and cryptocurrencies working in parallel.

Over the years, one major shortcoming of traditional money has been in the area of delivering welfare schemes. This was further highlighted by the lockdowns induced by the covid-19 pandemic. To soften the economic blow, the US government provided direct stimulus payments to millions of American families. But it was found that in many cases, the payment took weeks or even months to reach the beneficiary.

In India, the DBT program is currently in place to enable the transfer of subsidies directly to a person’s bank accounts. However, sending money via traditional banking channels is costly, as banks have to adhere to KYC and anti-money laundering requirements. Since CBDCs are programmable money and can be embedded with a computer code, a digital rupee can hold KYC information within itself. Therefore, a central bank-issued digital currency can ultimately lower the cost incurred by banks.

“The first key use case of CBDC will be in lowering the cost of KYCs because today, the banks are spending a lot of money on such procedures," said Charles d’Haussy, managing director (Asia Pacific) at ConsenSys, a blockchain engineering company providing advisory services to Hong Kong Monetary Authority and Bank of Thailand on how to make a transition to digital tokens. “Looking at a transaction to check whether it is legitimate or not is complicated and involves a lot of money. But this is a requirement imposed by most central banks," added d’Haussy.

The challenges

While the introduction of a CBDC will no doubt be a fundamental shift, the precise nature of its implications will largely depend on the design choices that the Reserve Bank of India makes.

“The RBI will need to think about the degree of anonymity when transacting via CBDC; whether CBDC can be utilized for both retail payments (peer to peer) or will it be limited to wholesale payments (among banks and financial institutions for the settlement of transactions); and whether CBDC units will be interest bearing," said Shilpa Mankar Ahluwalia, head of fintech at Shardul Amarchand Mangaldas.

Cryptocurrencies were founded on the principle of decentralization, privacy and inclusion. That is precisely why concerns abound about the nature of central bank intervention in this realm since centralized ownership would make all money traceable by the government. According to Policy 4.0’s Ratna, all the major Indian entities that she has worked with are aware of the privacy concerns. “In (the) case of India, it is unlikely that RBI will sanction a full surveillance-like system," she said.

There are also several business challenges that need to be analysed while developing a viable framework for a CBDC. “Based on the particular CBDC model which may be adopted in India, banks will need to carefully think through the impact on their business model, devise a nimble product strategy and accordingly develop requisite technology & operations capabilities. This would eventually need to extend to cross-border CBDC rails. Further, governance and control structures will need to be updated to manage the unique risks which will arise with CBDC," said Vijay Mani, partner at Deloitte India.

In terms of the legal framework, the roll out of a digital currency by RBI will require the central bank to clearly set out the roles and responsibilities of not just RBI but also banks, financial intermediaries and fintech platforms to enable such entities to provide an interface and layer products onto the CBDC ecosystem. Several amendments to existing banking norms will be required to enable a digital currency (as opposed to paper currency).

“Right now, most countries will be looking to keep their banking infrastructure (since) it will be too disruptive to replace them, but it will eventually get to a place where banks will be there, but their functions will be very different. Banks and fintech could become indistinguishable," said Ratna.

Ultimately, while CBDCs may still be at a nascent stage and the roll-out, use case, design and functionality of the currency may all differ from one country to another, experts do agree on one thing—money is evolving and the next iteration will inevitably be a digital form of currency.

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